Mumbai: The news that beleaguered solar energy giant SunEdison is looking to sell its interest in a solar project it won in November last year by quoting a record low tariff of Rs.4.63 per unit has been doing the rounds in industry circles for quite some time. While the latest reports confirm the talks, what is intriguing is the time SunEdison is taking to arrange equity funds or investors for the project, which it claimed was won at a reasonable tariff.
The project has no counter-party risk. It has to be developed in a solar park and power from the plant will be purchased by profit-making government enterprise NTPC Ltd.
The delay, therefore, validates stakeholders’ concerns that aggressive bids for solar power are irrational and come with high risks. “The inability of a company to achieve financial closure on a plug-and-play-model solar project is an outcome of the winner takes all, self-fulfilling approach that has not worked across infra sectors in the past and it would be sacrilegious should solar take the same road,” says Rupesh Agarwal, advisory partner and leader–energy at BDO India LLP.
A channel check by Mercom Capital Group a month back found many projects which were won at low bids (less than Rs.5 per unit) to be waiting for financial closure due to concerns about project returns. Market risks and fear of execution are holding back banks from lending to projects won by smaller firms, according to Kartik Shetty, analyst-credit and market research at India Ratings & Research.
To be sure, projects will be viable even if tariffs fall to Rs.4 per unit, provided investors take a hit on returns, points out Shetty. The grey area is how low the project returns (internal rate of return or IRR) will fall.
For a project with a capital cost of Rs.5 crore per megawatt, the minimum tariff should be Rs.5 per unit to achieve an IRR of 13% for equity investors, said India Ratings. Historically, returns have averaged around 20%.
According to ICRA Ltd, the recent low bids were made with “tight assumptions” and even a slight change in debt costs and project utilization levels can impact returns negatively. Project cash flows can be impacted by a mere 1% drop in utilization level and Rs.0.5 crore per megawatt rise in capital cost, ICRA added.
Of course, most international firms are expected to raise debt at much cheaper rates (2-4%) and for longer tenures like 15-17 years. But hedging costs (estimated at 6-7%) can nullify a substantial part of the interest rate arbitrage. Besides, there is no proven track record whether solar modules have performed consistently over 15-17 years.
Apart from this, there are external risks. Solar plants can be erected in 12-15 months, whereas a grid will take around three years to build. A one-year delay in power evacuation can increase the payback period.
Also, the low tariff bids are made on the assumption that component costs will continue to fall. But module prices, a key component for solar plants, are unlikely to fall drastically in the near term. “We expect module prices to escalate in the medium term due to strong demand in 1H2016 from the US and China,” Shetty added. “Further, the capacity expansion of silicon wafers (key raw material used in cells) in the global wafer industry has not kept pace with that of the recent cell and module capacity additions. Thus, we expect the shortage of silicon wafers to put upward pressure on the prices.”
All these issues are making investors wary. So much so that some are calling for regulation of bids (pre-conditions) to ensure long-term development of the sector. “The high capex short gestation cycle and a strong pipeline of tenders warrants policy de-risking, by capping project size and pipeline under development to ensure competitiveness, participation and limit adventurism, that helps reinforce India as the global solar investment destination,” BDO India’s Agarwal added.